Commentary: Clearing debts might be key to reinvigorating economy

MichaelCasey

NEW YORK (MarketWatch) — “Americans are renowned for their skill in business and their spirit of enterprise. But in general they are considered bad debtors.”

So wrote Alexis de Tocqueville, that great observer of U.S. society, when he reflected in 1831 on the remarkable frequency with which the citizens of his host country entered bankruptcy. The itinerant Frenchman, who was baffled by how a nation with such strong “chastity of morals” and “habits of work” could be so indifferent to the practice of not paying one’s debts, called it “one of the greatest stains on the American character.”

One wonders, however, whether Tocqueville would be so disparaging of America’s easygoing attitudes if he were conducting cross-Atlantic comparisons now. In Europe, the continent of his birth and a place that is now beset by economic stagnation, sliding property prices and soaring unemployment, people are straitjacketed by laws that make it near impossible to have their debts forgiven. In the U.S., by contrast, growth is returning and both consumer and business confidence are picking up after millions of foreclosures and personal bankruptcies were rammed through the courts.

The American economic system, shaped by an ethos that treats failure as a necessary if unwelcome element of entrepreneurship, is doing what it does best: renewing itself. The fact that Europe’s can’t do the same should ensure that investment flows favor the U.S. over time. So although the euro’s higher interest rates are currently giving it the edge over the dollar, the greenback’s future is brighter. And a key reason for that is because the U.S. economy has a better mechanism for clearing its debts.

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No one wants to end up before a bankruptcy judge — the immediate consequences are bad for both debtor and creditor — but since business failures and job losses are a fact of life, America’s busy bankruptcy courts provide a mechanism for cleansing the financial system. The slate is cleared. The parties move on with their lives and try something else.

In 2011, there were 1.36 million personal bankruptcies filed in the U.S., which represents a per capita ratio of 450 per 100,000 people. And while comparable figures aren’t available for the euro zone as a whole, country data show that the region forgives debts at far slower rates. Data compiled by German debt management company Creditreform show that six relatively wealthy member states — Germany, France, Austria, Finland, the Netherlands and Spain — averaged a personal bankruptcy filing ratio of 96 per 100,000, less than a quarter of the U.S. rate.

A compelling expose by Gabriele Steinhauser and Matthew Dalton in The Wall Street Journal last week detailed the challenges individual Europeans face in having their debts cleared. In Spain, where the bursting of a mammoth housing bubble and a sharp spike in unemployment has left millions of homeowners underwater on their mortgages, there is no mechanism for ever writing down an individual’s unpaid debts. Such permanent bankrupts will struggle to rent apartments or sign cellphone contracts — offering a fairly good explanation for why only 999 bankruptcies were filed in Spain in 2011.

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In Ireland, another crisis-wracked euro-zone country with legions of busted homeowners, only 30 people filed for bankruptcy that same year. Many more, one can assume, were dissuaded from doing so by laws stating that debts will only be forgiven after 12 years in which a court supervises the debtor’s finances and requires that nearly all disposable income is dedicated to creditors.

Indebted Spaniards and Irishmen are between a rock and a hard place. There’s no means of obtaining personal debt relief, and their governments are so constrained by the austerity demands of their own creditors in the EU that the pool of state welfare assistance is also shrinking.

So, while American households have used mortgage defaults to cut their total outstanding debt levels by more than $1 trillion since the crisis in 2008, household debt in the euro zone hasn’t fallen at all. And that means that European consumers will take a lot longer than their American counterparts to start to grow their spending again.

That stain on the American character isn’t quite as ugly as Tocqueville saw it to be.

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